There’s a lot of event risk in Europe this Sunday that could trigger market volatility on a broad scale. Markets, preoccupied by recently improving euro zone economic data, may be too complacent about the potential outcomes of national elections in Italy and a party vote in Germany which could stymie hopes for a new grand coalition government.

As it stands, opinion polls in Italy, the euro zone’s third largest economy, suggest that there will be no clear winner in the general election but that the centre-right coalition of Silvio Berlusconi’s Forza Italia and the Eurosceptic Northern League, led by Matteo Salvini, as well as the populist 5-Star Movement, will all poll well.

If the Northern League does end up playing a prominent role in a new Italian government investors should bear in mind that in January, Salvini characterised the euro as “a failed experiment that has hurt Italy’s economy”, adding that “a country that does not control its currency is not a free country”.

At the very least the election outcome could lead to prolonged political horse-trading. There was a risk of a “non-operational” government in Italy after March 4, European Commission President Jean-Claude Juncker was quoted as saying last week, adding that “a strong market reaction in the second half of March is possible”.

If Juncker has concerns, perhaps markets should have too, particularly given that Italy’s debt-to-gross domestic product, at 132 per cent in 2016, is the highest in the euro zone apart from Greece.

In fairness, although the bond market has largely so far shrugged off risk associated with the upcoming election, Italian government debt yields did tick up a little last week. At 2.07 per cent on Friday, the yield on Italy’s 10-year bond was up 8 basis points over the week, arguably nothing spectacular, but still the biggest weekly rise since December based on data from Tradeweb.

Meanwhile, Italy’s 5-year credit default swap, representing a price at which exposure to Italian government debt can be insured, hit a five-week high last week of 105 basis points, according to data from IHS Markit, but it’s still far below the 180 level seen when a referendum defeat prompted Italy’s Europhile Prime Minister Matteo Renzi to resign in December 2016.

To some extent the foreign exchange options market is reacting to the concentration of event risk on March 4

In Germany, the euro zone’s largest economy, the inconclusive result of last year’s national election has led to a situation where Chancellor Angela Merkel’s conservative Christian Democrats party is hoping to re-establish a grand coalition with the centre-left Social Democrats (SPD).

But the successful formation of such a grand coalition depends on approval from the SPD’s rank-and-file membership in an internal party referendum with the result to be announced on Sunday. Analysts at the Dutch bank ING feel the risk that approval by SPD members may not be forthcoming “is underpriced, with a 40-50 per cent chance the coalition deal is rejected.”

To some extent the foreign exchange options market is reacting to the concentration of event risk on March 4. Last week saw a rise in two-week implied volatility for the euro reflecting an appreciation of the risk of greater swings in the currency markets.

Additionally, two-week risk reversals have shown some increase in demand for euro/US dollar put options as opposed to calls. As purchasing a euro/US dollar put option gives the buyer the option to sell euros, the move in risk reversals might suggest some degree of seeking protection against a weaker euro ahead of and immediately after Sunday.

Yet “demand for euro downside protection in the options market has been relatively modest compared to in the run up to last year’s French election”, wrote Lee Hardman at Japan’s MUFG on Friday. “Market participants currently appear relatively relaxed over the outcome from both votes.”

That relaxed state may also be discerned in the continuing existence of a very large long euro/short US dollar position evidenced in data released on Friday by the US’ Commodity Futures Trading Commission (CFTC) for the week ending February 20.

While the CFTC data showed a slight fall in the size of the long euro position to 126,126 contracts from 127,289, that still represents a short US dollar position of almost US$19.5 billion. That’s quite a bet on the euro given Sunday’s dual event risks in the currency bloc.

Markets may have collectively concluded that, however events play out in Germany and Italy on March 4, the upside prospects for the euro remain undimmed. Maybe that will prove correct. But there is a real risk that the outcome of Sunday’s votes will leave investors wrong-footed.